Exchange-Traded Funds
4. Recent Developments of ETFs and Conclusions
ETFs continue to grow in popularity with the asset percentages of 60% in the broad US market, 26% in international, 9% in sector US, and 5% in the bonds in 2006. While all classes are growing, interna- tional leads the trend with 71% increase. Figure 2 shows the increas- ing growth of international ETFs traded in the US in recent years.
In particular, international iShares ETFs of Barclays Global Investors, including Asian, European, and American ETFs, allow investors to diversify their holdings in international markets by using investment vehicles that represent diversified baskets of international assets which can be traded in dollars on US markets. US investors who are inter- ested in purchasing stocks of international companies can purchase ETFs rather than worrying about trading in local currencies through overnight markets and holding undiversified positions in international stocks (see Tse and Martinez, 2007).
China ETFs were the best investments in 2006 because of boom- ing economic growth in China. iShares FTSE/Xinhua China 25 Index (FXI) and PowerShares Golden Dragon Halter USX China (PGJ) returned 81% and 51%, respectively. The growing Russian economy is also attracting investor interest. Investment manager Van Eck Global recently launched Market Vectors-Russia ETF (RSX), a new exchange-traded fund. The fund is the first ETF listed in the US that enables investors to gain exposure to a wide spectrum of Russian companies.
Single-country iShares also provide targeted exposure to different economic sectors. Understanding sector exposures is the primary step in designing investment strategies that incorporate both geographical and sector preferences in a single investment product. Table 2 sum- marizes the iShares Single-Country ETFs.
0 20 40 60 80 100 120
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year
Asset Value (US$ Billions)
0 5 10 15 20 25 30
Market Share (%)
Asset Value Market Share
Figure 2. International ETFs traded in the US: 1996–2006.
Source: Investment Company Institute
No international ETFs were traded in the US before 1996.
Table 2. Top Five Single-Country iShares within Each Sector as of March 2007
Country Ticket Symbol Sector %
A. Consumer Discretionary
Japan EWJ 21.2
Netherlands EWN 15.4
Malaysia EWM 15.3
France EWQ 14.6
Germany EWG 14.3
B. Consumer Staples
Netherlands EWN 19.0
Mexico EWW 18.4
Malaysia EWM 12.8
Switzerland EWL 12.5
Belgium EWK 12.0
C. Energy
Canada EWC 29.3
Brazil EWZ 25.1
Italy EWI 17.2
UK EWU 16.2
France EWQ 12.7
D. Financials
Belgium EWK 61.7
Singapore EWS 55.0
Hong Kong EWH 52.6
Australia EWA 48.2
Italy EWI 47.9
E. Healthcare
Switzerland EWL 30.6
UK EWU 8.1
France EWQ 8.04
Belgium EWK 5.9
Japan EWJ 5.8
F. Industrial
Sweden EWD 29.0
Singapore EWS 21.7
Malaysia EWM 18.0
Japan EWJ 16.6
Hong Kong EWH 14.8
(Continued)
The currency ETFs such as the Euro Currency Trust (FXE) from Rydex Investments allow investors to gain exposure to the currency markets. Currency ETFs are similar to money-market funds but denominated in foreign currencies. A declining dollar has increased the popularity of these ETFs since they were introduced in 2006.
However, like the international ETFs, currency ETFs have a higher expense ratio (ranging from 0.4% to 0.8%) than most US index ETFs.
Investors should also beware of the notoriously unpredictable cur- rency markets.
Table 2. (Continued)
Country Ticket Symbol Sector %
G. Information Technology
Taiwan EWT 57.9
South Korea EWY 26.4
Sweden EWD 18.1
Japan EWJ 12.6
Germany EWG 6.2
H. Materials
South Africa EZA 27.0
Brazil EWZ 26.1
Australia EWA 20.5
Mexico EWW 18.7
Canada EWC 15.6
I. Telecommunications Services
Mexico EWW 39.0
Spain EWP 17.1
Austria EWO 13.6
Singapore EWS 12.6
South Africa EZA 11.1
J. Utilities
Spain EWP 14.7
Germany EWG 14.4
Hong Kong EWH 13.0
Malaysia EWM 12.4
Italy EWI 10.8
Source: www.iShares.com.
A series of ETFs introduced by ProShares in 2006 do not merely attempt to merely achieve the same return as their underlying indexes.
Ultra QQQ ProShares (QLD) seeks daily investment results that cor- respond to twice (200%) the daily performance of the Nasdaq-100 Index, while UltraShort QQQ(R) ProShares (QID) doubles the inverseof the Nasdaq index. Another example of an innovative ETF is the oil futures ETF, USO, which is like a traded commodity. The fund invests primarily in futures contracts for light and sweet crude oil that are traded on the New York Mercantile Exchange.
A continuous array of fundamentally weighted, timeliness-seek- ing, dividend-focused and other specialty exchange-traded funds are rolling out. These ETFs have been launched with the same premise:
market-cap weighted indexes are inefficient because they get caught up in market bubbles; one can outperform the market by using an alternate methodology. However, it takes more time to evaluate the performance of these specialty ETFs. The SEC is also considering the applications for actively managed ETFs. Despite higher transaction costs, some fund managers expect actively managed ETFs to outper- form their counterparts tied to market indexes. However, many stud- ies have shown that it is difficult to outperform or add value above indexes. Moreover, big mutual-fund companies are likely to continue to dominate because of their plentiful marketing resources and pow- erful distribution networks.
In conclusion, ETFs offer investors many advantages. They are flexible, transparent, liquid, and low-cost. The popularity of ETFs is soaring among institutional and individual investors as advisors are using more ETFs to provide various strategies to clients. However, it is worth noting that if the strategy is erroneous, ETFs will also make it easier for investors to more efficiently lose money.
References
Chamberlain, M. and J. Jordan, 2006, An Introduction to Exchange Trade Funds, iShares Publications.
Elton, E. J., M. J. Gruber, G. Comer, and K. Li, 2002, Spider: Where are the bugs? Journal of Business, 75, 453–427.
Lauricella, T. and D. Gullapalli, 2007, Fast-money crowd embraces ETFs, adding risk for individual investors, The Wall Street Journal, A1, March 17.
Traulsen, C. J., 2000, Exchange-traded funds: What you should know, Morningstar Articles, id=3503, August 24, 2000.
Tse, Y. and V. Martinez, 2007, Price discovery and informational efficiency of international iShares funds, Global Finance Journal18.